Innovation and Distribution: An Equilibrium Model of Manufacturing and Retailing

Abstract

This paper proposes a model of the distribution channel to study the decisions of manufacturers, retailers and consumers. The model is used to study how retail distribution affects manufacturing and consumers. As the cost of distribution falls, the retail sector increases assortment size and allows a larger mass of manufacturers to enter. Consumers can buy more variety and, depending on entry primitives, may have lower travel costs as more stores enter. The same primitives also determine vertical pricing power. Under conditions, the equilibrium of the model predicts that the national retail sector is a fraction of the total economy only depending on the demand for variety. It is not affected by, e.g., consumer transportation cost or income. Data support this prediction.